Download Part 2 - Queen`s Economics Department

ECN 204
Introductory Macroeconomics
Instructor: Sharif F. Khan
Department of Economics
Ryerson University
Fall 2005
Assignment 2 (Part 2)
Deadline: October 22, 2004
1. Refer to the accompanying table in answering the questions which follow:
(2)
Real domestic
output,
billions
(1)
Possible levels
of employment,
millions
(2)
Aggregate Expenditures
(C a + I g + X n + G ) ,
billions
9
$500
$520
10
550
560
11
600
600
12
650
640
13
700
680
a. If full employment in this economy is 13 million, will there be an inflationary or
recessionary gap? What will be the consequence of this gap? By how much would
aggregate expenditures in column 3 have to change at each level of GDP to eliminate
the inflationary or recessionary gap? Explain.
b. Will there be an inflationary or recessionary gap if the full-employment level of
output is $500 billion? Explain the consequences. By how much would aggregate
expenditures in column 3 have to change at each level of GDP to eliminate the
inflationary or recessionary gap? Explain.
c. Assuming that investment, net exports, and government expenditures do not change
with changes in real GDP, what are the sizes of the MPC, the MPS, and the
multiplier?
(a) A recessionary gap. Equilibrium GDP is $600 billion, while full employment GDP is
$700 billion. Employment will be 2 million less than at full employment. Aggregate
expenditures would have to increase by $20 billion (= $700 billion -$680 billion) at
each level of GDP to eliminate the recessionary gap of $100 billion. Therefore, the
multiplier in this economy is 5 (= 100 ÷ 20 ) .
(b) An inflationary gap. Equilibrium GDP is $600 billion, while full employment GDP
is $500 billion. Aggregate expenditures will be excessive, causing demand-pull
inflation. Aggregate expenditures would have to fall by $20 billion (= $520 billion -
$500 billion) at each level of GDP to eliminate the inflationary gap of $100 billion.
Therefore, the multiplier in this economy is 5 (= 100 ÷ 20 ) .
(c) From column 2 and 3 of the table, it is clear that for every $50 billion increase in real
domestic output, the consumption expenditures increases by $40 billion because the
investment, net export and government expenditures do not change with changes in
real GDP. Therefore, MPC = .8 (= $40 billion/$50 billion); MPS = .2 (= 1 -.8);
multiplier = 5 (= 1/.2).
2.
Assume the consumption schedule for a private open economy is such that
C = 50 + 0.8Y. Assume further that planned investment and net exports are independent
of the level of income and constant at Ig= 30 and Xn = 10. Recall also that in equilibrium
the real output produced (Y) is equal to the aggregate expenditures: Y = C + Ig + Xn.
a. Calculate the equilibrium level of income for this economy. Check your work by
expressing the consumption, investment, and net export schedules in tabular form and
determining the equilibrium GDP.
b. What will happen to equilibrium Y if Ig changes to 10? What does this tell you about
the size of the multiplier?
(a) Y = C + I g + X n = $50 + 0.8Y + $30 + $10 = 0.8Y + $90
Therefore Y − 0.8Y = $90, and 0.2Y = $90, so Y = $450 at equilibrium.
Real domestic
output
(GDP = YI)
$
0
50
100
150
200
250
300
350
400
450
500
C
Ig
$ 50
90
130
170
210
250
290
330
370
410
450
$30
30
30
30
30
30
30
30
30
30
30
Xn
$10
10
10
10
10
10
10
10
10
10
10
Aggregate
expenditures,
open economy
$90
130
170
210
250
290
330
370
410
450
490
(b) If Ig decreases from $30 to $10, the new equilibrium GDP will be at GDP of $350,
for with Ig now $10 this is where AE also equals $350. This indicates that the
multiplier equals 5, for a decline in AE of $20 has led to a decline in equilibrium
GDP of $100. The size of the multiplier could also have been calculated directly
from the MPC of 0.8.
3. Work through the numerical example in the Appendix to Chapter 7 of the text
book (10th edition).